When the economy goes south, consumers are often bombarded with conflicting messages about whether they should save or spend their money.
Those messages are especially confusing now, as the government takes bold financial action to restore confidence and restart the economy and with presidential candidates offering their takes on what should be done to put the U.S. back on firm financial ground. What's more, we're on the cusp of the holiday shopping season, when retailers typically start to woo consumers with incentives and cut-rate sales to bolster their bottom line before the close of the year.
"That's always the rub in recessions: that what's good for the individual — save, save, save — isn't always good for the economy, which is helped if people get out there and spend, spend, spend," says Greg Daugherty, executive editor for Consumer Reports.
Daugherty believes there is a middle ground for consumers, where they'll continue to spend for the things they need. In an effort to become more "value conscious," Daugherty says, consumers will be cutting back on some purchases. He says it's part of a sense of hunkering down that everyone is feeling, including those whose jobs and incomes are secure.
Credit Culture
The culture of consumption in the U.S. has roots in a number of issues.
"Until recently, at least, the household net worth of the U.S. sector was very strong, so there was a lot of wealth that would support consumption activity," says James Poterba, a professor of economics at the Massachusetts Institute of Technology and the president of the National Bureau of Economic Research.
The enormous increase in debt levels in the U.S. has been spurred, in part, by home equity lines of credit and the refinancing of mortgages, he says. "We see the ratio of mortgage debt to housing value approaching a long-term high," Poterba says.
Credit cards have also been a factor. Credit card spending has "gone kind of crazy" in recent years, says Daugherty, with easy access to consumer credit encouraging people to keep on spending. Some U.S. credit card television ads have reinforced the credit culture message by depicting the person who opts to spend cash as slowing down the retail line and, by implication, slowing down commerce and the larger economy.
But the opposite may be true: Paying cash, or thinking twice about using one's credit card, could actually have a positive impact for both consumers and the economy, Daugherty says.
Credit card usage is likely to decline going forward, he says. The reasons include rising interest rates, reduced credit lines offered by credit card companies and increasing frugality among consumers. The combination will likely cause people to "think twice about how much debt they want to rack up," he says.
Lower Savings Rate
Since 1970, the U.S. household savings rate has consistently declined and remained lower than that of other countries with influential economies, such as Japan and Germany. Of the three nations, the U.S. is the only one in which the savings rate has dropped into negative territory in nearly four decades, according to data from the Organization for Economic Cooperation and Development.
The U.S. household savings rate in the U.S. has been below 1 percent since the first quarter of 2005. In the third quarter of 2005, it turned negative.
That's "clearly indicative of American households living beyond their means," says Jacob Kirkegaard, an economist at the Peterson Institute for International Economics. It's also not sustainable, he says, adding that he believes the U.S. savings rate will increase as a result of the financial crisis.
Meanwhile, Americans' consumption story is the inverse of the savings tale. Since 1970, consumption in the U.S. as a percentage of GDP has been at or above 64 percent. These levels are substantially higher than the rates for Germany and Japan.
The Challenges Of Saving
Saving money isn't made any easier when the government urges you to spend tax refunds and rebates to help boost the economy, says Anna Lusardi, a professor of economics at Dartmouth who studies savings and consumption issues. She says those kinds of government incentives send the wrong message to consumers who are already heavily in debt.
"How about saving a buck or two?" she says. "One of the reasons we had this crisis is because people have been borrowing excessively. I think the message to promote financial security is not to spend more but to spend less."
Lusardi says she's concerned that consumers are being discouraged from putting money away for the future because the low savings rate gives the impression that no one else is bothering to do so.
Daugherty of Consumer Reports says consumers have a hard time saving, in part, because of the disparity between wages — which have barely kept up with inflation — and the skyrocketing prices for goods and services.
Even retirees save less than they used to, adds Poterba. Compared to those who retired in the 1960s, today's retirees are less inclined to build up assets to cover the costs of medical care and other expenses in their golden years, partly because the current structure of Social Security and Medicare and Medicaid reduces the urgency to do so, he says.
Financial Literacy
One major obstacle to saving, says Lusardi, is low levels of financial literacy. At the heart of this is learning to save from an early age.
"If you don't fully grasp the power of interest compounding, you might not fully understand how quickly that can grow if you borrow at 20 percent," she says.
Lusardi says the U.S. needs to find a way to make saving as easy as borrowing. One possibility is creating an automatic IRA account for people with no access to pension plans through an employer.
The call for financial literacy is starting to take hold. Yale University said this week that it would offer a free online course on financial markets taught by some economic heavyweights, including economist Robert Shiller, author of The Subprime Solution, with guest lectures from David Swensen, Yale's chief investment guru, and other financial luminaries.
Holiday Outlook
As the holiday season approaches, Daugherty says he expects that people will be less extravagant in their gift-giving, but they won't hold back altogether. "My guess would be that people will be more strategic in their shopping this year, looking for bargains and waiting for sales, maybe buying online in some cases to avoid the cost of riding all over the place."
Meanwhile, businesses should be prepared for some sharp elbows. Daugherty says he expects to see a lot of competition when it comes to advertising and sales in an attempt to get customers through the door. One upside, he says, is that consumers with some cash to spend are likely to find an abundance of bargains.
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